Tax Tribunal: Interest on borrowed funds for project setup is capital receipt, not taxable income

The Tribunal allowed the assessee's appeals and dismissed the revenue's appeals. It held that interest earned from borrowed funds, temporarily deposited for setting up a plant, should be capitalized. Additionally, interest earned from capital subsidy and equity, linked to the project's establishment, was also deemed capital receipts. The Tribunal relied on precedents emphasizing the capital nature of such receipts. The decision aligned with Supreme Court rulings and upheld the CIT(A)'s treatment of the interest, distinguishing it from cases where funds were not directly related to project setup.

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Issues Involved:
1. Whether the interest earned from borrowed funds (short-term temporary deposits) can be capitalized.
2. Whether the interest earned from capital subsidy and equity should be treated as capital receipts or revenue receipts.

Issue-wise Detailed Analysis:

Issue 1: Capitalization of Interest Earned from Borrowed Funds
The primary issue for the assessee was whether the interest earned from borrowed funds, which were temporarily deposited, could be capitalized. The Tribunal noted that the assessee was engaged in setting up an Integrated Petrochemical Complex and had not yet commenced operations. It was highlighted that the interest earned on these deposits was adjusted against the capital work in progress and not reflected in the Profit & Loss Account, as the project was still under construction.

The Tribunal referenced the Supreme Court's decision in Bokaro Steel Ltd., which established that interest earned on borrowed funds, if inextricably linked with the setting up of a plant, should be capitalized and not treated as revenue income. Similarly, the Supreme Court's decision in Karnataka Power Corporation supported this view, stating that such interest receipts are capital in nature and should reduce the cost of the assets.

Given these precedents, the Tribunal concluded that the interest earned from the borrowed funds, which were temporarily deposited, was indeed inextricably linked to the setting up of the plant and should be treated as a capital receipt. Thus, the assessee's appeal on this issue was allowed.

Issue 2: Treatment of Interest Earned from Capital Subsidy and Equity
The revenue's appeals challenged the CIT(A)'s decision to treat the interest earned from capital subsidy and equity as capital receipts. The Tribunal noted that the CIT(A) had followed its earlier decision in the assessee's case for AY 2009-10 and 2010-11, which treated such interest as capital receipts.

The Tribunal reiterated that the interest earned on unutilized capital subsidy and equity was inextricably linked to the process of setting up the project. The funds were specifically meant for the project, and any interest earned would reduce the capital subsidy required from the government. This treatment was supported by the Supreme Court's decisions in Bokaro Steel Ltd. and Karnataka Power Corporation, which held that such receipts should be capitalized and not treated as income.

The Tribunal also distinguished the case from the Supreme Court's decision in Tuticorin Alkali Chemicals & Fertilizers Ltd., where the interest earned on surplus funds was treated as revenue income because the funds were not inextricably linked to the setting up of the plant.

Therefore, the Tribunal upheld the CIT(A)'s decision to treat the interest earned from capital subsidy and equity as capital receipts, dismissing the revenue's appeals.

Conclusion:
The Tribunal dismissed all the revenue's appeals and allowed all the assessee's appeals, concluding that:
- The interest earned from borrowed funds, which were temporarily deposited, should be capitalized and not treated as revenue income.
- The interest earned from capital subsidy and equity should be treated as capital receipts, as they are inextricably linked to the setting up of the project.

Order Pronounced:
The order was pronounced in the open court on 22 October 2020.

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